Now in a bind, Fed might opt to halt the taper

Opinion: Does the granddaddy of all central banks still have control?

By

MichaelCasey

Columnist

Bloomberg

With the Turkish lira reversing all of its massive overnight gains within just 15 hours of the central bank’s giant interest-rate increase, then South Africa’s rand plunging despite a boost in rates there, it seems like emerging-market authorities have completely lost control of their financial conditions.

Now the ultimate question: Does the granddaddy of all central banks still have control?

With the Federal Reserve due to make a monetary decision at 2 p.m. today, its yearlong dance with a global market obsessed with its fine-tuning of U.S. monetary liquidity arrives at an extremely difficult phase — an especially awkward pirouette, perhaps.

The Federal Reserve finds itself in a bind

(15:00)

Paul Vigna and Michael Casey discuss the Federal Reserve meeting, and Dan Gallagher looks at the reaction to Apple's earnings.

Does the Fed press ahead with its plan to remove another $10 billion from its monthly bond-buying program and so maintain an image of predictability in a sea of tumult? Or would that risk an even bigger panic by investors, who fret about the end of a long period of near-free money, and force it to make a credibility-challenging reversal in the days or weeks ahead?

We know what the Federal Open Market Committee wants to do. It wants to stick with the plan. But can it? Are markets in control now? My sense is that this risk-averse Fed — an institution still in the hands of Ben Bernanke, the architect of quantitative easing, for three more days — will worry most about the worst-case scenario and stand pat.

Not only is that not the consensus expectation among economists, who are mostly calling for the Fed to cut its monthly purchase target to $65 billion from $75 billion, but it’s also not the best solution. A halt in tapering would open the Fed up to criticism that it is beholden to markets, a challenge to its long-term credibility. The best solution is for the Fed to take a stand against the markets and live with the short-term cost of turmoil.

But past experience--for example, the Fed’s decision in September to not begin tapering despite economists’ expectations that it would--suggests the bank will err on what it sees as the cautious side. It would justify this halt as a temporary move, giving markets time to stabilize. And it could point to the disappointing December jobs report for justification: Official data didn’t show the labor market improving as well as expected.

The events overnight represented a shift of magnitude in what until now has been a just mini emerging-market crisis. A few days ago, it was easy for Fed policy makers and investors to dismiss turmoil in places like Turkey, South Africa, Brazil and Russia as distant problems, singular to each country’s unique experiences and problems. But the fallout in other, supposedly healthier, emerging markets has steadily increased and now spills over to all risk assets, including U.S. stocks. We are still a long way from the 1997 Asian crisis, but this moment has some disturbing similarities.

What’s unsettling is how quickly investors changed their minds after Turkey’s central bank increased rates at midnight in Ankara. The whopping increase of more than four percentage points in its overnight lending rate was first applauded as a bold assertion of its independence from Prime Minister Tayyip Erdogan. The Turkish lira surged 3% against the dollar, and U.S. stock futures jumped in after-hours trading.

But since then, the Turkish currency has lost all of those gains and more, and U.S. stocks are suffering again. The troubling message, sharply articulated by investors, is that they have lost faith in policymakers’ capacity to fight the tide of capital outflows.

Whatever the Fed chooses to do, let’s hope it can restore that confidence.

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